A Model of Financial Crises: Coordination failure due to bad assets
AbstractThis paper constructs a model of financial crises that can explain characteristic features of the global financial crisis of 2008-2009, namely, the widespread freezing of asset transactions, the sharp contraction of aggregate output, and a deterioration in the labor wedge. This paper assumes that banks sell corporate bonds in the interbank market to raise money for short-term loans. The emergence of bad assets subsequent to the collapse of the asset-price bubble and asymmetric information among banks causes a freezing in the asset trading among banks (the market for lemons). Market freezing constrains the availability of bank loans as working capital for productive firms, causing output and the labor wedge to deteriorate. Given the market freeze, no proper incentives exist for banks to reveal their bad assets and dispose of them.
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Bibliographic InfoPaper provided by Research Institute of Economy, Trade and Industry (RIETI) in its series Discussion papers with number 11010.
Length: 34 pages
Date of creation: Feb 2011
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This paper has been announced in the following NEP Reports:
- NEP-ALL-2011-03-12 (All new papers)
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